On The Case

Revisiting Delaware law and Securities Act forum selection clauses

(Reuters) - Last week’s reports about Uber and Lyft preparing to go public in 2019 mean that it’s time to think again about whether corporations can force investors to litigate Securities Act claims in federal court via provisions in their corporate charters.

As you may recall, there’s litigation under way in Delaware Chancery Court on this very question. In 2017, Blue Apron, Roku and Stitch Fix all included federal-court forum selection clauses in their charters when they went public. Plaintiffs' lawyers at Block & Leviton sued to have the clauses declared invalid. Vice-Chancellor Travis Laster heard summary judgment arguments.

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I told you last month that the Blue Apron case is getting a lot of attention as a harbinger for an eventual test of the legality, under Delaware corporate law, of mandatory shareholder arbitration clauses. Some very eminent securities law professors are of the view that Delaware’s corporate code and state-court precedent on restricting shareholder litigation allows corporations to use their charters and bylaws to curtail breach-of-duty claims under state law – but not to interfere with federal securities claims. Under their reasoning, corporations can’t force shareholders to arbitrate federal securities claims because those claims are outside the scope of corporate charters and bylaws, which are nothing more than internal compacts on state-law corporate governance issues.

Vice-Chancellor Laster’s summary judgment decision in the Blue Apron case will be the first time a Delaware court addresses the question of whether Delaware law allows corporations to use corporate charters and bylaws to restrict shareholders’ control over their federal securities claims. So even though Laster surely won’t have the last word on the issue – and won’t even be considering a mandatory arbitration clause – securities lawyers are keeping a close watch on the Blue Apron case as an early indicator of what Delaware will say about corporations forcing shareholders to arbitrate federal claims.

It could turn out, however, that the answers we get from the Blue Apron case will leave many of those big questions unresolved.

That’s because of the nature of the forum selection clauses Blue Apron, Roku and Stitch Fix included in their corporate charters. The provisions all require shareholders to go to federal court to litigate claims under Section 11 of the Securities Act of 1933. (The biotech Moderna, which went public last week, has a similar clause in its bylaws and Lyft has signaled its charter will also include a forum selection clause.) As you know, the U.S. Supreme Court ruled earlier this year in Cyan v. Beaver County Employees Retirement Fund that shareholders can bring Section 11 claims – which involve alleged misstatements or deception in IPO filings – in either state or federal court. The forum selection clauses in the Blue Apron case direct investors to bring claims in particular federal courts, not state court.

The forum selection clauses say nothing about fraud claims under the 1934 Securities and Exchange Act – and that seems to be by design. Vice-Chancellor Laster himself has previously ruled (in 2015’s In re Activision) that ’34 Act fraud claims do not arise from the contractual relationship between the shareholder and the corporation but from the corporation’s allegedly false statement. A securities fraud claim under Rule 10b-5, the vice-chancellor said, is like a tort claim against the corporation. Under his reasoning, a company could no more use its charter or bylaws to restrict an investor from filing a ’34 Act claim than it could stop a slip-and-fall victim who happens to be a shareholder from filing a lawsuit.

In the Blue Apron litigation, defense lawyer William Chandler of Wilson Sonsini Goodrich & Rosati, who is himself a former Delaware chancellor, argued that there’s a fundamental difference between shareholders’ Section 11 claims under the ’33 Act and their fraud claims under the ’34 Act. Section 11 claims, he said, “necessarily arise from (investors’) stock ownership.” Shareholders don’t have standing to sue under Section 11 unless they bought shares in the IPO, he said. The reasoning that Vice-Chancellor Laster used in the Activision case, which addressed whether ’34 Act fraud claims are transferred when shares are sold or belong to the allegedly defrauded investor, doesn’t apply to claims arising from IPO misstatements, according to Chandler.

“Securities Act claims are, by definition, tied to a plaintiff’s stock ownership,” he told Laster at the summary judgment hearing. “The federal forum provisions thus necessarily involve and regulate the interactions of managers and stockholders in their capacities as such.”

At the hearing, Laster pressed Chandler on the broader implications of the case, asking the former chancellor where he should draw a line between internal affairs claims that fall within the scope of Delaware’s authority and federal claims that cannot be restricted by corporate bylaws and charters. Chandler first suggested the vice-chancellor could avoid questions about the implications of his ruling by focusing only on the particular forum selection clause before him. Laster prodded for a substantive answer.

“The nature of precedent is that it gets built on,” the vice-chancellor said. “And so the question in my mind is, what is the appropriate framing of this connection between stock ownership and the claim such that it can be regulated in the charter or in the bylaws?”

Chandler said the answer should be that Delaware law allows corporations to use charters and bylaws to streamline claims arising from “a relationship that is internal to the company,” regardless of whether the claims are grounded in state or federal law. By his analysis, Section 11 claims are on one side of the line; ’34 Act fraud claims may be on the other side.

If Laster and the Delaware Supreme Court agree, corporations considering mandatory arbitration will have an interesting choice: Is it worth riling investors by compelling arbitration of Section 11 claims if you can’t also rein in 10b-5 class actions via mandatory arbitration clauses in charters and bylaws?